Wednesday, 11 June 2014

Economic Recovery – Reasons to be Pessimistic

The economy seems to
be picking up so why are economists still so dour?

Economists are not known for being moody but many are
depressed when it comes to the state of the global economy. This seems out of place at a time when
economic recoveries in some countries are showing signs of taking hold and
stock markets are setting record highs. The
mood among economists was already negative after being caught out by the global
financial crisis. Are economists right
to be worried or just hung up on past mistakes?

Why so glum?

My father inquired, after a recent post on my blog, why my views had to be so
downbeat. Given that much of the
business cycle is driven by the sentiment of consumers and businesses, his line
of thinking was that the economy would jump back to life if we could all just
be more positive about the future.
People would spend more while companies would invest and take on more
workers. All we would need is economists
to tell us that everything will be alright.

The problem is not that economists are always a grumpy
bunch. The problem is the opposite –
that economists have been overenthusiastic in the past. This optimism was fuelled by a belief that
economic theory could provide a route to a steady rise in prosperity. Instead, economists have been chastened as a
result of their previous ideas being proved wrong by the global financial
crisis. The crisis has also focused
minds on what can go wrong. Now, even periods of prosperity are seen to have a darker side and to create the seeds for trouble in the future.

Grumpy for a reason

It may just be the case that economists are caught in a
crisis of confidence. There is a core
belief among economists that markets have the ability to correct
themselves. This means that any periods
of weak economic growth should only last until the economy gets back on its feet again. There is much data on the economy to get
excited about. Consumer spending is up,
buoyed by the job market recovering faster than expected. The worst of the crisis seems to be behind us
and stock markets reflect this new upbeat outlook.

Yet, economists have learnt their lessons and know better
than to place too much trust in the data.
Behind the numbers lurks a less cheerful story. Investment by companies is low with few
businesses seeing opportunities to expand despite balance sheets laden with
cash. One reason for this is that labour productivity is weak. This means that the extra earnings for
companies from employing more workers are likely to be poor. Low labour productivity also implies that
wages are not likely to rise much which raises concerns about whether households will struggle to pay off rising levels of debt. A lack
of new innovations suggests that investment and productivity may not improve
for a long time to come, prompting talk of prolonged stagnation.

When the markets are not functioning normally, it is
typically the government that steps in to correct any problems. However, the governments in many countries
have been more hindrance than help.
Mismanagement of government finances, slow and timid responses to
crises, and a lack of forward-looking policies are common complaints. With voters lacking genuine alternative political parties,
politicians have become engrossed in petty political positioning rather than
constructive policy making. Managing the
economy has been left to central banks which has caused its own problems.

This is why Your Neighbourhood Economist is one of many who
struggle to find reasons for cheer. It
would be great to be caught up in the euphoria that has taken hold of the
financial markets but economists have been burnt too badly to get carried
away. Only time will tell if the gloom
among economists is warranted.